Strategic Frameworks for Outsourcing Decisions Part Two

Vivek Sood continues to explain how to strategically outsource, this is the second part of three parts

Navigating The Grey Area

The two cases described above are relatively easier to deal with since they fall into two opposite extremes of to do and not to do. A great majority of cases are however, in the grey area where the answers are not as clear-cut. Just saying “it depends on your core competence” does not help because no competence comes with a label CORE, or NON-CORE attached to it. Additionally, what is core today, may well become non-core in future and vice-versa.

I have frequently been asked “Are there any practical set of guidelines that can help me decide when to outsource and when not to?”

The answer is always the same – it depends on the circumstances of the case. However, the key questions to ask are:

1. Can we configure, create and manage an outsourcing relationship that gets us the desired results better than if we manage the operation ourselves?

2. What gives the real advantage of outsourcing:

a. Speed of ramp-up and execution?

b. Capability of the outsourced service provider that are difficult to replicate internally?

c. Economies of scale available to the outsourced service provider that is difficult to outsource internally? Why?

d. Economies of scope? What is the source of such economies?

e. Cost arbitrage opportunity because of lower cost base of the service provider?

f. Patent, copyright or other proprietary knowledge base?

3. How can we replicate this advantage without outsourcing?

4. What is our bias – in favour or against?

Based on the above discussion, a relatively simple framework can be developed as shown below:

Figure 1: When to Outsource, and When Not to Outsource

The two critical criteria on which the decision hinges are whether the purported loss of capabilities, relationships or infrastructure are business critical, and whether these are irrecoverable.

Business critical capabilities are those capabilities absence of which can easily kill a business in medium term. Likewise we can define the business critical relationships and infrastructure.

In region A, where any of these – capabilities, relationships or infrastructure – are business critical, you will have to manage the outsourcing relationship very carefully to make sure that that a slight misstep from your service provider does not cause massive repercussions in your business. Logistics outsourcing, IT outsourcing and many other outsourcing arrangements fall under this category. A good example of a business critical capability leading to massive business losses is the case of oil rig Deepwater Horizon where business critical functions were outsourced to third parties, yet British Petroleum faced heavy penalties.

On the other hand, irrecoverability refers to the cost of developing these capabilities, relationships or infrastructure from scratch, once they are lost. In region C, where these costs are prohibitive, in general you would not like to lose these capabilities, relationships or infrastructure, and hence create an arrangement where you retain some stake in these.

Of course if the situation is such that the loss is both business critical and irrecoverable, you will find it easier to retain ownership of such capabilities, relationships and infrastructure. Hence it will not be advisable to outsource in such circumstances – as shown in region B.

Finally, there will be situations where the loss of capabilities, relationships or infrastructure is neither business critical, nor irrecoverable as shown in region D. Then, it is easy to make a decision to outsource and reap benefits from what outsourcing provides.

While there are often no clear cut answers, the above matrix serves to provide useful decision making guidelines. Outsourcing can be made to work in a great majority of cases. However, equally it can fail because of a predisposition against outsourcing. There is no point blaming the service providers, or the practice of outsourcing itself. If the predisposition is against outsourcing, it may well be due to poor management of the process in the past.

Having made the decision to outsource, what is the best way to do make it work for your company?

Outsourcing myths and reality

One of the most persistent myths that continue to perpetuate despite ample evidence to the contrary is that once you outsource, you can relax and let them handle all the work. This is perhaps the most pervasive myth in the higher echelons of corporate circles today, believed by even some of the most astute business executives. However in reality, this can be dangerous. Putting together an outsourcing arrangement does not transfer your core issues to the service provider; rather you swap one set of problems with another - e.g. internal logistics management problems with logistics relationship management problems!

While this topic calls for an entire article by itself, let’s look at some of the problems likely to surface after outsourcing begins: Unpleasant surprises - such as cost creep, technical expertise being lower than expected, lack of flexibility to incorporate changing business needs, potentially large cost over-runs on account of services that were assumed to be included in the service contract but are not, loss of real visibility, control and direction.

The fact is that even after the outsourcing, your management will still be working just as hard on the outsourced functions. The sole difference being that the time they save on the management of the department will now be spent in managing the relationship with the service provider, with some relationships even degenerating into games of contractual head-butting and variations management tactics for which both the IT outsourcing and the building construction industry are becoming notorious.

To achieve proper power-balance, and to facilitate easy switching from underperforming service providers, modularization of processes is required. I recommend a good mix of detail-oriented contracts and on-going relationship management.

Another pervasive myth – often perpetuated by the organizations handling outsourced functions - is there is an equal win-win partnership. A real partnership, by its very nature, is defined by co-dependence where the relationship is indispensable to both parties, as judged by a measure of how much each party would hurt if the relationship fell apart. The truth, in most cases of outsourcing, is that this pain is not too much!

Most service providers have fingers in multiple pies, and have learnt not to rely on just a few customers for their business, for very obvious reasons. For instance, Foxconn – Taipei-based manufacturer – makes components for Apple’s iPhones, iPads but also has clients such as Intel, Microsoft and Samsung. From their point-of-view even if a few customers pulled out, they would have contingency plans to optimize their asset utilization. Even from the customer’s perspective, with the increasing modularization of the supply networks, most service providers are now providing a commoditized service, despite all the hype surrounding technology integration, business process integration and infrastructure integration. None of the service providers is considered indispensable. And this is true of all service providers regardless of their scale of operations.

Even if it were a true win-win partnership - just as when a pair dances, one person takes the lead to improve the joint performance - it is preferable that the lead be taken by the customer whose business is at stake. Corporations should relinquish the lead to the contractor only at their own peril.

Results-Focused Outsourcing and Modularization

The approach that we have developed and successfully used combines the key parameters discussed above in order to effectively prepare, engage, select, integrate and manage the service providers for the modularized set of services. In fact those five words are the five key steps in the process as shown in the figure 2. Each step consists of further sub-steps - each one of which has its own set of template, heuristics or methodology to facilitate rapid deployment of outsourcing strategies.

Figure 2: How to Outsource Well

The results achieved through a systematic, logical and pragmatic approach such as this one far surpass any others.

Part three, the final part of Vivek's three part article will be coming out next week with the stages of outsourcing...